Published: November 5, 2012 at 11:00 am

Caterpillar Inc. (NYSE:CAT) is down 13% in the last six months, bringing the stock price to a 9% decline for 2012. With good results- in the third quarter, earnings were 49% higher than in the third quarter of 2011- the $56 billion market cap construction and mining equipment company trades at only 9 times trailing earnings. While the company is not likely to replicate that growth rate over the next year, the market appears very skeptical that it will even be able to sustain its current business. The primary concern is that a slowdown in China will ripple through mining and other economic activity in countries such as Australia (which was actually the driver of growth in Asia/Pacific last quarter with direct Chinese revenue down). If this decline is strong enough, it could offset continued good performance in the United States (North America grew faster than the Asia/Pacific region in Q3 versus a year earlier).

Wall Street analysts do expect somewhat lower earnings in the next few quarters, and so the forward P/E multiple rises to 10 (still quite cheap); however, they do expect growth to resume shortly thereafter, yielding an attractive five-year PEG ratio of 0.7. Even if Caterpillar Inc. missed these expectations slightly, it would still end up undervalued at the current price. Caterpillar also pays a 2.4% dividend yield, which is not high enough to make it an income stock but is a small plus. Overall, we would say that the lower stock price for Caterpillar makes it a good buy for investors who aren’t too exposed to global macro conditions already.

In the second quarter of 2012, Renaissance Technologies increased its stake in Caterpillar Inc. to a total of 2.6 million shares; Renaissance has been so successful since its inception that founder Jim Simons is now a multi-billionaire (see more stock picks from Renaissance Technologies). Billionaire Ken Fisher’s Fisher Asset Management reported a position of 3.9 million shares at the end of June, which was about even with what the fund had owned at the beginning of April (find more stocks that Fisher Asset Management owned). Columbus Circle Investors, a combination asset manager and hedge fund managed by Donald Chiboucis, sold 21% of its shares during the quarter but still had 1.8 million shares in its portfolio according to its 13F filing (research what else was in the fund’s portfolio).

The best peers for Caterpillar are CNH Global NV (NYSE:CNH) and Joy Global Inc. (NYSE:JOY). Concerns about global macro have impacted these smaller equipment companies as well, and their earnings multiples are also in the 9-10 range. They are also like Caterpillar in that their most recent quarter showed an increase in net income compared to the same period in the previous year, though the growth rate is lower than Caterpillar’s. We’d say that these three companies are close enough in terms of their valuations that we would go with the largest of the three, which is Caterpillar.

We can also compare Caterpillar to Vale SA (NYSE:VALE) and Freeport-McMoRan Copper & Gold Inc. (NYSE:FCX), for the benefit of investors who might in fact want to buy a stock tied closely to the global economy because they believe that the market is being overly bearish. These mining companies both trade at 8 times forward earnings estimates, so they are a bit lower priced than Caterpillar. Each of them has already been impacted by economic conditions, as revenue was down 15-20% in the third quarter versus Q3 2011 (causing larger declines in earnings). The dividend yields look good here as well, but we think that we’d be willing to pay the small premium for Caterpillar as its recent business performance has been considerably better.

It might be a good idea to stress test Caterpillar’s numbers before buying, but we see it as a value opportunity. Its earnings multiples are low and give the company something of a margin of safety in case of poorer Asia/Pacific numbers.

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